Estimating

Cash Flows
Three Components of
Project Flows
Initial Outlay (Initial Investment) IO
Periodic Operating Project Flows
Terminal Year Non-Operating Flows

Remember: It is the Incremental Flow that Matters

Some Basics of Cash
Flow Estimation
Incremental Cash Flow
Opportunity Cost
Sunk Cost
Salvage Value
Investment Tax Credit
Interest Cost
Depreciation/Allocated Cost
Tax Savings on Depreciation
Accelerated Depreciation
Initial Outlay
How much is required to start up the project?
The Depreciable Basis
Cost Plus
Installation
Modification
Preparation

Investment in Net Working Capital

Cost of Land(?)
You already own the land
The land has substitute use
The land otherwise has no use
Initial Outlay-
Replacement project
How much is required to start up the project?
Total Need : Cost Plus Installation + Initial Investment in
Net Working Capital
Need Reduction: Net Salvage Value of the Old Equipment
Gross salvage value tax on capital gain (or + tax reduction due to write off)
Depreciation and Its
Impact on IO
Depreciation Methods
Straight Line
Units of Output
Declining Balance
Double Declining
Sum of the Years Digits
Asset Class
Tax Holiday
Half-Year Convention (in the USA)
Accelerated
Depreciation
For Qualified investments in machinery and plants:
50 percent may be depreciated in the 1st year.
30 percent may be depreciated in the 2nd year.
20 percent may be depreciated in the 3rd year.
Tax book value zero after that
Periodic Cash flows
Must be incremental if it is a replacement project
Must account for opportunity cost
Project Operating Cash Flows
(Asssumed 3 year Accelerated
Depreciation Applies)
Revenue (Year 1) Amount
Less Cost of Goods Sold Amount
Gross Profit Amount
Less Operating Expenses Amount
(Excluding Depreciation)
Operating Profit before Depreciation Amount
Less Depreciation (50% of Depreciable Basis) Amount
Operating Profit after Depreciation Amount
Less Taxes Amount
Operating Profit after tax and DepreciationAmount
Add back Depreciation Amount
Project Operating Cash Flow, CF1 Amount

Project Operating Cash Flows

(Asssumed 3 year Accelerated
Depreciation Applies)
Revenue (Year 2) Amount
Less Cost of Goods Sold Amount
Gross Profit Amount
Less Operating Expenses Amount
(Excluding Depreciation)
Operating Profit before Depreciation Amount
Less Depreciation (30% of Depreciable Basis) Amount
Operating Profit after Depreciation Amount
Less Taxes Amount
Operating Profit after tax and Depreciation Amount
Add back Depreciation Amount
Project Operating Cash Flow, CF2 Amount
Project Operating Cash Flows
(Asssumed 3 year Accelerated
Depreciation Applies)
Revenue (Year 4 and on) Amount
Less Cost of Goods Sold Amount
Gross Profit Amount
Less Operating Expenses Amount
Operating Profit before Taxes Amount
Less Taxes Amount
Project Operating Cash Flow, CFt Amount
Periodic Flows with Accelerated
Depreciation: Example
A new project is expected increase revenue by Taka
80,00,000. Cost of Goods sold is normally 30 percent of
revenue. Operating cost before taxes and depreciation is
14 percent of revenue. Initial investment in the project
(depreciable basis) is Taka 1,00,00,000 and it qualifies for
accelerated depreciation over 3 years. It has a projected
life of 5 years. The tax rate is 38 percent. Determine the
project operating flows for 5 years.
Project Operating Flows
Short and direct formula
CFt = (1-t) Before tax increase in operating Cash Flow +
t* Increase in depreciation
Terminal Year Cash Flow
with Unlimited Life
Basically: Gordon Growth Model

CFty = OCFty(1+g)/(k-g)
Example:
If you plan to sell a business at the end of 5th year when cash
flow is (5th year) Taka 50,00,000 and growing at 10% per year
and you (or any investor) want 25% return, you should be
able to sell it for
Terminal year CF = 50,00,000(1+.10)/(.25-.10)
= Taka 3,66,66,667
Inflation and Cash Flow
Estimation
Cash Flow Estimation under inflation
Real Cash flow or nominal cash flow
Discount rate under inflation
Comprehensive Cases
Determine CFo
Determine Periodic CFs
Adjust the final year CF with the Terminal Year non-
operating flow
Draw or visualize the time line
Discount to determine NPV
Determine IRR
Apply Decision Rules
Estimating free cash
flows
Project after-tax Operating Income + Tax savings on
depreciation (Or net income after tax plus depreciation)
Minus Incremental investment in net working capital
Minus incremental investment in Fixed assets
Plus increase in liabilities